Explain the difference between service company and merchandising company accounting with respect to inventory.

Explain the difference between service company and merchandising company accounting with respect to inventory.

• A. Service companies typically maintain large inventories; merchandising companies have little to none; manufacturing includes production inventory.
• B. Service companies typically have no inventory; merchandising companies hold inventory and recognize COGS when goods are sold; manufacturing includes production inventory.
• C. Service companies recognize COGS when services are performed; merchandising recognizes COGS when cash is received.
• D. All company types use identical inventory methods.

Answer: (B)

The difference hinges on whether the business holds merchandise inventory and when the cost of that inventory becomes cost of goods sold. Service firms usually don’t carry merchandise inventory at all because they provide intangible services; their primary costs are labor and other operating expenses, so there isn’t a COGS figure tied to inventory. Merchandising firms purchase goods for resale and keep those goods as inventory, which is shown as a current asset. They recognize COGS when the goods are sold, with the period’s COGS calculated from beginning inventory plus purchases minus ending inventory (and inventory method choices like FIFO, LIFO, or weighted average affect the numbers). Manufacturing firms go a step further and hold production inventories—raw materials, work in process, and finished goods—and track the cost of manufacturing goods before they’re sold; COGS then includes the costs transferred from finished goods as they are sold. So the statement that service companies typically have no inventory, merchandising companies hold inventory and recognize COGS when goods are sold, and manufacturing includes production inventory best captures these distinctions.

The difference hinges on whether the business holds merchandise inventory and when the cost of that inventory becomes cost of goods sold. Service firms usually don’t carry merchandise inventory at all because they provide intangible services; their primary costs are labor and other operating expenses, so there isn’t a COGS figure tied to inventory. Merchandising firms purchase goods for resale and keep those goods as inventory, which is shown as a current asset. They recognize COGS when the goods are sold, with the period’s COGS calculated from beginning inventory plus purchases minus ending inventory (and inventory method choices like FIFO, LIFO, or weighted average affect the numbers). Manufacturing firms go a step further and hold production inventories—raw materials, work in process, and finished goods—and track the cost of manufacturing goods before they’re sold; COGS then includes the costs transferred from finished goods as they are sold. So the statement that service companies typically have no inventory, merchandising companies hold inventory and recognize COGS when goods are sold, and manufacturing includes production inventory best captures these distinctions.